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For several years now, the government could safely count on the transfer of a hefty surplus from the RBI for a slice of its revenue. And thanks to the surprise demonetisation of high-value currency notes in November, many had initially expected the government to get a windfall this year. A back-of-the-envelope calculation, however, shows the RBI's income in 2016-17 (Jul-Jun) may have been significantly depleted due to demonetisation and the management of its spillover effects, and while a fall in the central bank's surplus is not unheard of, this could be the sharpest in over a decade.
 
According to a calculation, the RBI's surplus to the government could fall by over 300 bln rupees from last year's 659 bln rupees, assuming its profits from other sources such as foreign exchange transactions remain constant and most of the demonetised notes have come back to the banking system. It should go down because of two factors, one is the interest payments on the reverse repo (operations) that were conducted during the year by RBI to suck out liquidity from the system. Second, the cost of printing new currency notes during the latter half of the year.
 
Ever since the government banned 500 and 1,000-rupee currency notes starting Nov 9, the central bank has had to rely heavily on its reverse repo operations to impound liquidity from the banking system. True, the RBI has also employed other measures - temporary and some more permanent. The use of such measures, however, has not been extensive.
 
On any given day, the RBI has held multiple variable rate reverse repo auctions. This is in addition to the fixed rate reverse repo window under the Liquidity Adjustment Facility which is available daily at the end of the day. But surely, can interest on variable and fixed rate reverse repos be sizeable enough to have a significant impact on the RBI's surplus to the government? Not really.
 
On an average daily basis, banks parked around 3.3 trln rupees at the RBI's reverse repo windows - fixed and variable rate - between Nov 11 and Jun 30, the last day of the RBI's financial year. On the funds absorbed through variable rate reverse repos, whose durations varied from overnight to 91 days, the RBI paid a rate of interest of up to 6.24%. For the daily fixed rate reverse repos, the rate of interest was constant at 5.75% untilApr 5, and 6.00% thereafter. As such, the interest payment numbers are large indeed. In absolute terms, the interest outgo on the reverse repo operations works out to around 130 bln rupees for Nov-Jun.
 
The central bank's liquidity management operations in 2016-17 have also seen a significant departure from previous years. While the RBI was a net lender to banks - and would have thus earned interest from its repo operations - in 2015-16 and before, the situation changed starting early April 2016 when it decided to move systemic liquidity closer to neutral, ending a six-year long regime of maintaining liquidity in deficit mode.
 
Again, similar to the interest outgo on reverse repos, the amount of interest the RBI earned through its repo operations is more significant than one might think. In 2015-16, on an average, the banking system had a daily outstanding repo borrowing of 1.0 trln rupees. The minimum interest rate for these loans is the RBI's repo rate. Using conservative estimates, the interest received by the RBI from its repo operations during 2015-16 works out to around 70 bln rupees. This 70 bln rupees, which is a pure profit for the RBI, will also be missing from its 2016-17 surplus. Therefore, on account of repo and reverse repo operations alone, the RBI's surplus may have suffered a setback of around 200 bln rupees.
 
[To be continued tomorrow...]
Silkrose Fiscal Serviecs LLP & Adroit Research Team 
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